Se lo están pasando muy bien
 

I've come across this sentence from peppa pig, and it should be simple.

Peppa y George se lo están pasando muy bien.

The English equivelent should be 'they are having fun', but I don't really understand 'se lo'. Is se an indirect object pronoun form of le/les? Does lo means it here? And what about 'they are passing' mean?

Can someone explain it for me? Thank you!

You're inquiring after a set phrase, which will always be difficult to understand. Like idiomatic expressions, set phrases don't necessarily have a word-for-word explanation/translation.

Reducing the phrase to its basic pattern (the infinitive, with appended object pronouns), we have 'pasárselo bien'. The direct object pronoun 'lo' is used in Spain and perhaps in other places. In Mexico, and perhaps other places, the phrase is 'pasársela bien'. And in still other places of the world, the pronoun 'se' is not used.
No matter how it's used in your area, the phrase roughly translates as 'have a good time'.

The particular version of the set phrase that you posted has its verb in the present progressive form. It can, of course, appear in other tenses (equivalent to 'pasan' (have fun), 'pasaron' (had fun), 'will have fun', 'would have had fun', you get the idea).

The 'se lo', or 'se la' (or without the 'se'), component precedes the conjugated verb.

The direct object pronoun refers to the activity, but the activity isn't relegated to a specific word, so its gender doesn't factor in (some will argue that their particular usage is the correct one). Use the phrase with the direct object pronoun that prevails in your area. And, just to confuse matters, 'las' is also heard in some places.

The pronoun 'se', if it's included in the phrase in your area, isn't replacing an indirect object pronoun. People argue that it's either a dative pronoun of interest or a pronominal pronoun.

All this boils down to is, learn how the phrase is used in your area and remember that it is a set phrase (that may change from place to place).

Thank you! That helps a lot!

Pretty sure "se" here is called "dativo ético". You can't really directly translate that as far as I know. Don't quote me on that though.